OECD Taxation Working Papers N. 2 – What is a “Competitive” Tax System? 1. Statements about the importance of tax systems being ‘competitive’ are often made by business, politicians, lobbyists and other commentators, but what does this term mean? 2. In everyday usage ‘competitive’ is a relative concept. When applied to a business, it would mean that the firm in question is able to produce its output at the same or lower cost than other firms in the same line of business, or that it has some other advantage over them such as the quality of its product. In most industries a competitive firm would (as a result of its cost or other advantages over its rivals) be able to earn returns in excess of its cost of capital. 3. It is more difficult conceptually to apply the term ‘competitive’ to an economy as a whole rather than a particular business. An economy is made up of many different firms (plus extensive public sector provision of services). Moreover the structure of its production and the pattern of its trade will depend on its comparative advantage relative to other economies.2 Specialisation in line with comparative advantage increases production efficiency and raises living standards. 4. For a typical advanced economy (where natural resources and primary products make up a relatively small part of domestic output) there are likely to be strong links between the competitiveness of its firms and the overall levels of productivity and living standards that the country is able to sustain. Individual firms may then be ‘competitive’ internationally (in the sense of having a cost or other advantage relative to their foreign rivals, given the exchange rate, etc); and if a firm is not competitive, then national output and income are likely to be higher if the resources it would have used are redeployed to another line of business where profit opportunities are better. 5. Most of the drivers of the competitiveness of firms lie within the domestic economy. Thus the World Economic Forum, for instance, in its Global Competitiveness Report defines ‘competitiveness’ as ‘the set of institutions, policies and factors that determine the level of productivity of a country’. The level of productivity in turn sets the sustainable level of living standards. The Global Competitiveness Report weights together data pertinent to 12 ‘pillars of competitiveness’: institutions, infrastructure, macroeconomic environment, health and primary education, higher education and training, goods market efficiency, labour market efficiency, financial market development, technological readiness, market size, business sophistication and innovation. 6. There are likely to be significant overlaps and interactions between these ‘pillars’ and views may differ on precisely how they translate into increased production efficiency and growth potential. However, one approach to examining the impact of tax on ‘competitiveness’ is to consider how tax policy and administration impact on the various ‘pillars’ and hence productivity, etc. In practice, most taxes (not just the corporate income tax) can have an impact on competitiveness, as section B below indicates. In practice, the underlying themes arising from taking a ‘competitiveness’ perspective are very similar to those explored in OECD work on Tax and Economic Growth (OECD 2010a) and the Tax Policy Brief on Tax Policy Reform and Fiscal Consolidation (OECD 2010b). 7. However, in considering how tax policy can help to generate economic growth and prosperity, each country’s tax system cannot be considered in isolation. In open economies where capital is mobile across boundaries and multinational enterprises play an increasing role in international trade and investment, tax regimes and tax rates can potentially have a significant influence on decisions about the location of production and investment. Section C accordingly explores notions of ‘international tax competitiveness’ and how they interact with other desiderata for tax regimes: raising sufficient revenues, fairness, economic efficiency, etc. Section D discusses further some of the problems of measuring international tax ‘competitiveness’. 8. Section E then sets out a few concluding observations on the implications for tax policy and the role that common principles (e.g. the OECD Model) and economic cooperation can potentially play. Matthews, S. (2011).
